What Is Return on Shareholders Equity?

Return on shareholders equity, or simply return on equity (ROE), refers to the amount of profitability a corporation experiences through shareholder investment. It is expressed in the following equation: return on shareholders equity equals net income divided by shareholders equity. This formula may slightly vary depending on the source; however, most financial formulas pertaining to return on shareholders equity use similar elements and relationships.

Capital, or the monetary resource necessary for many corporate functions, is cleverly generated through the sale of small portions of ownership in a company, or shares. If a company wanted to break itself into 100 pieces of ownership, for example, they would have 100 shares available for purchase. Of these shares, the company executives may want to maintain a majority, in this case, 51 shares. They could then sell the other 49 pieces of the company for a specified value related to company's overall worth. When the company is performing well, its value is increased, hence buying a piece of this company becomes more expensive — the opposite is true as well during times of poor performance.

If a person buys a share of a new company for a small amount of money, and the company experiences success so that its share value increases, this person may wish to sell his or her part ownership to obtain a profit. This is the basis for the trading of stocks. There are also a number of complex options available for this trading and manipulation of corporate success, all of which contribute to the esoteric stock market.

The formula for return on shareholders equity best fits within the concept of the stock market as a whole. The net income of a company, generally measured annually, describes its overall profits. This differs from gross income in that expenses are subtracted, meaning a net income reflects actual gains. When this number is divided by the summation of all shareholder's stakes in the company, that equals the return on shareholders equity value.

These calculations may seem trivial, but they are important in that they can yield specific information that can help all the players on the field. The ROE value can tell investors, employees, and analysts a number of things regarding company function. ROE helps to compare different companies within the same industry, and it can give investors clues as to when it is a good time to buy, sell, or hold a company's stock.